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Dell can't avoid low-cost PCs

The PC maker appears to be getting into the low-end PC price wars, tarnishing the company's above-the-fray image.

It appears that Dell is being dragged, kicking and screaming, into the low-end PC price wars, a development that could tarnish the company's above-the-fray image.

Dell's average selling price (ASP) per unit recently dropped about 10 percent, to $2,475, according to the company's first quarter earnings statement. Meanwhile, with demand for low-cost systems showing signs of expanding into business sector where Dell has made its name, executives have said that this year Dell will at last introduce PCs in the $1,000 range.

Falling ASPs generally mean declining profit margins. Margins are particularly thin in the sub-$1,000 sector, and vendors are forced to rely on volume to generate profits.

Most analysts remain optimistic about the company's growth potential, but part of that outlook stems from the fact that Dell has enjoyed higher-than-average ASPs. With this advantage shrinking, the view could change a bit.

Historically, Dell has catered to the corporate market, where high-end machines are in demand and profit margins don't depend on economies of scale. But even this market, which can be sluggish in responding to pricing trends, is beginning to jump on the sub-$1,000 bandwagon.

"It has taken the IS [information services] organizations a little while to readjust. They're not as quick to jump on the lower price points as the consumer sector," said Bill Schaub, a senior analyst at Dataquest. "They [Dell] have been fortunate, if not talented, at keeping the high-end client."

"However at some point, it's inevitable, particularly in the commercial market," said Schaub.

Relentless price compression and new corporate expectations fostered by $799 consumer PCs with almost all of the bells and whistles of a $1,500 business model are also ominous trends working against high-priced business systems.

Admittedly, the first quarter of 1998 was somewhat of an anomaly, industry watchers say. Huge amounts of excess inventory in the distribution channel and rapid price declines in computer components like memory forced vendors to cut prices to move inventory.

"Any concerns about Dell's ASP are misplaced," said T.R. Reid, spokesman for Dell. "Our reduction year-over-year is significantly lower than the industry as a whole and reflects component cost reductions. Our margins at all levels were actually up...We can put any concerns to rest pretty quickly," he said.

Dell marketing executives also dispute claims about ASPs affecting earnings. Dell excels at getting systems into the sales channel just as new technology comes out, according to Susan Rubino director of marketing, for Dell's Optiplex line of business PCs. This is a brief window of time when vendors can command high margins.

Dell will likely attempt to maintain its high-profit business model. And when Dell does deign to get its hands dirty, it's doubtful the sub-$1,000 PC will cause that same financial upheaval that it brought for others, analysts say. "I don't think we should get profits confused with margins," said Schaub. "If their return on assets and investments is high, they should make a profit even at lower margins."

To date, Dell has largely stayed on the sidelines as competitors like Compaq, IBM, and Packard Bell watched their profit margins erode as they scrambled to offer rock-bottom prices on their low-end systems.

Dell's low-end system will likely be based on the next generation of Intel's Celeron processor for low-cost PCs. Dell executives have said in the past that the company will probably wait for the next-generation "Mendocino" chip before making a big push into Celeron-based computer systems.

"To the degree they go after Celeron business, it will be because existing customers want a Dell product in that category," said Kurt King, an analyst at Montgomery Securities. "There's definitely an upside in that this market represents an opportunity to gain market share."

"But for it to be a significant positive, there needs to be an offset at the higher end," King said. Dell's servers are the higher-end product which will offset the lower profit margins that are part of the sub-$1,000 PC package, according to King, who notes server growth has been in the triple digits.